Predictors of Municipal Bankruptcies and State Intervention Programs: an Exploratory Study
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PREDICTORS OF MUNICIPAL BANKRUPTCIES AND STATE INTERVENTION PROGRAMS: AN EXPLORATORY STUDY Laura N. Coordes* & Thom Reilly† Why do some struggling cities file for bankruptcy while others, facing similar circumstances, do not? This Article builds on the literature examining the causes and consequences of municipal fiscal distress by exploring specific factors that lead municipalities to seek help from the state and federal government. Viewing municipal opportunities and constraints through political, economic, and legal lenses, this Article helps to explain the nuances of municipal decision making. After identifying eight factors that may serve as predictors of municipal insolvency, we studied cities in fiscal distress with an eye toward uncovering the circumstances that led each of these cities into and, if applicable, out of, their financial predicaments. Union density, unfunded pension liability, and financial mismanagement were the three most prevalent factors in our sample population. Our analysis suggests that scholars and policymakers should focus their efforts on using bankruptcy relief in conjunction with state aid programs in order to address these primary sources of municipal distress more comprehensively. * Associate Professor, Arizona State University Sandra Day O’Connor College of Law. Many thanks to Karen Bradshaw, Kaipo Matsumura, Troy Rule, Erin Scharff, and Cathy Hwang for their advice and suggestions on previous drafts. Special thanks to Madison Levine for research assistance. † Director, Morrison Institute for Public Policy and Professor, School of Public Affairs, Arizona State University. Many thanks to my research assistant, Larry Gulliford for his work on this manuscript. Electronic copy available at: https://ssrn.com/abstract=2867610 INTRODUCTION Chicago and Detroit are alike in many ways. Both iconic Midwestern cities have publicly struggled with crime, corruption, and financial instability. In recent years, ratings agencies have downgraded the credit ratings for both cities.3 And, although quite different in terms of size and industry concentration, both cities share many of the same financial problems, including mismanagement of finances and high unfunded pension liabilities.4 Yet, Detroit chose to address its problems through bankruptcy, while Chicago, at least so far, has not. Why do some cities file for bankruptcy while others, facing similar financial problems, do not? This question has many possible answers. One reason that municipal bankruptcy is not utilized consistently across cities is that access to bankruptcy relief differs across the fifty states. Although federal law allows any entity meeting the definition of a “municipality” to seek bankruptcy protection using chapter 9 of the U.S. Bankruptcy Code, municipalities also need specific authorization from the states in which they are located before they can file for relief.5 Only twelve states unconditionally authorize municipal bankruptcy access; another twelve provide conditional authorization, two prohibit the practice outright, and the remainder provide no express authorization.6 This patchwork of access provisions, combined with fear about the municipal bankruptcy process itself, leads many municipalities to utilize alternative fiscal relief remedies, even if their state does provide them with access to bankruptcy. A related reason is that municipal bankruptcy, generally speaking, is rare and therefore somewhat of an unknown quantity. Between 1980 and 2012, fewer than 250 chapter 9 cases were filed.7 Even during the Great Recession, when bankruptcy filings as a whole rose, municipal bankruptcies remained scarce: from 2008 to 2012, only one out of every 1,668 local 3 Fitch cuts Chicago credit rating in wake of pension ruling, REUTERS (Mar. 28, 2016), http://www.reuters.com/article/chicago-ratings-outlook-idUSL2N170121; Detroit Credit Rating Downgraded Again, S&P Cuts General Obligation Debt Further into Junk Status, REUTERS (Jul. 19, 2013), http://www.huffingtonpost.com/2013/07/19/detroit-credit-rating- downgrade-sp-debt-junk_n_3622643.html. 4 See case studies in Part II, infra. 5 11 U.S.C. § 109(c) (providing for state authorization). 6 Cory Eucalitto, Kristen De Pena & Shannan Younger, Municipal Bankruptcy: An Overview for Local Officials, STATE BUDGET SOLUTIONS (2013), https://www.alec.org/article/municipal-bankruptcy-an-overview-for-local-officials/. 7 Keren Deal, Judith Kaminkar & Edward Kamnikar, A descriptive case study of the Greene County, Alabama bankruptcy 21(3) J. of Pub. Budgeting, Acct. & Fin. Mgmt., 337, 338 (2009). Electronic copy available at: https://ssrn.com/abstract=2867610 22-Sep-16] PREDICTORS 3 governments filed for bankruptcy, and most of these filings were small utility authorities and special taxing districts rather than cities and towns.8 Still, a small yet significant wave of high-profile filings occurred on the heels of the Great Recession, testing municipal bankruptcy’s efficacy and bringing more attention to the process. If cities and towns continue to utilize chapter 9 in the wake of the recession, municipal bankruptcy may begin to offer more predictability and consistency than an ad hoc state program hastily created to address municipal distress. Studying how municipalities choose to overcome distress, whether through bankruptcy or otherwise, is further complicated by the vast array of different state laws that impact a municipality’s fiscal health. To date, the municipal decision-making process has remained largely inaccessible. To gain a better understanding of this process, this Article presents a novel framework for studying municipal choices relating to fiscal distress. Through case studies of 19 cities that have experienced distress over the past eight years, it examines factors that contribute to a municipality’s fiscal health, as well as factors that influence a municipality’s options when it comes to distress relief. In doing so, this Article contributes both to the literature focusing on the use and efficacy of municipal bankruptcy9 and to the literature studying how fiscal crises have led municipalities to seek relief in the first place.10 8 Governing, Bankrupt cities, municipalities list and map, GOVERNING DATA (2014), http://www.governing.com/gov-data/municipal-cities-counties-bankruptcies-and- defaults.html. 9 See, e.g., Michael W. McConnell & Randal C. Picker, When cities go broke: A conceptual introduction to municipal bankruptcy, 60 U. Chi. L. Rev. 425 (1993) (describing how municipal bankruptcy could be used by courts to force prudent yet politically unpopular decisions on local officials); Omer Kimhi, Chapter 9 of the Bankruptcy Code: A solution in search of a problem, 27 Yale J. Reg. 351 (2010) (observing some of bankruptcy’s harmful effects and advocating for proactive state oversight in lieu of bankruptcy); Clayton P. Gillette, Fiscal federalism, political will, and strategic use of municipal bankruptcy, 79 U. Chi. L. Rev. 281 (2012) (studying the power of bankruptcy courts and arguing that they should be allowed to impose resource adjustments on municipalities); David A. Skeel & Clayton P. Gillette, Governance reform and the judicial role in municipal bankruptcy, 125 Yale L.J. 1150 (2016) (contending that bankruptcy must also address governance dysfunction within the municipality to be effective as a long-term remedy); Laura Napoli Coordes, Restructuring municipal bankruptcy, 2016 Utah L.R. 307 (2016) (expressing concerns that municipal bankruptcy law in practice is out of touch with the broader goals of the bankruptcy system). 10 Keeok Park, To file or not to file: The causes of municipal bankruptcy in the United States, 16(2) J. Pub. Budgeting, Acct. & Fin. Mgmt., 228 (2004) (developing a theory as to why municipalities file for bankruptcy and suggesting that governments in municipal bankruptcy be explored separately from those in severe fiscal distress); Jamie Peck, Pushing austerity: State failure, municipal bankruptcy and the crises of fiscal federalism in the USA, 7(1) Cambridge J. of Regions, Econ. & Soc’y, 17 (2013) (studying this area after 4 PREDICTORS [22-Sep-16 Studying municipal decision-making is critical to determining what types of fiscal relief will be effective for any given municipality. Using the framework developed in this Article, scholars and policymakers can better understand and identify the relative strengths and weaknesses of chapter 9 relief vis-à-vis various state programs for each particular municipality. Importantly, this Article’s case studies and findings provide strong evidentiary support for the notion that chapter 9 municipal bankruptcy and state relief can work together and need not be viewed as mutually exclusive or as working at cross purposes. This Article proceeds in four parts. Part I traces the historical development of chapter 9 bankruptcy and state programs and provides an overview of our methodology and approach to the issues raised in this Introduction. Part II is this Article’s analytical heart, presenting case studies that showcase key examples of the various city-state interactions that influence municipal decision-making. Part III puts our findings into context and discusses their implications. Part IV concludes by emphasizing how this Article’s framework will contribute to future research in this area. Finally, an Appendix describes the case studies not discussed in Part II. I. BACKGROUND This Part begins by outlining the historical development of chapter 9 of the U.S. Bankruptcy Code and the concurrent rise in state relief